What are “Life Insurance Settlements”?

Up until recently I had never heard of a life insurance settlement aka. “Life Settlement”. That is because up until the beginning of the AIDS epidemic the idea wasn’t really very popular. But at that point a lot of people knew that their life expectancy was short and needed money for medical treatment but really didn’t have much in the way of assets except a life insurance policy. As they say “necessity is the mother of invention” and so this need for money gave birth to the Life Insurance Settlement industry.

There are actually two different forms of life insurance settlements. The first is called a “viatical” and this is basically where a person has developed a terminal disease and needs the money for treatments and so he sells the rights to collect on his policy to a third party in exchange for cash now and the second is just a straight life settlement for an older person.

Life Settlement Example

A recent NY Times article gave an example of a 38 year old man who developed brain cancer and needed money for treatments. He was able to negotiate through a company specializing in innovative settlements to sell his life insurance policy for cash up front. Initially the buyer offered $250,000 for a $500,000 policy. The negotiation company was able to get the offer raised to $305,000. Once the sale takes place the buyer becomes responsible for the insurance payments for the rest of the insured’s life. At the point of his death they collect the full face value of the policy.

The buyer is betting that they won’t have to continue making payments for very long and will make a substantial gain rather quickly. The seller is betting that he will live longer and that this money will help him do that. Surprisingly, the ground work for life insurance settlements was laid way back in 1911 in a Supreme Court case when Justice Oliver Wendell Holmes noted in his opinion that life insurance possessed all the ordinary characteristics of property, and therefore represented an asset that a policy owner may transfer without limitation.

Why Not Just Borrow Against Your Policy?

Typically, a whole life policy might have a bit of a cash value built up but nowhere near the face value (value you receive at death). So you might not get much if you cashed it in or borrowed against it even though it could be worth much more, shortly. In the above case, since the insured was only 38, he may have only built up a few thousand dollars worth of cash value because the insurance company estimates that he will have another 30 years to be paying before he would collect. So if the cash value was only $3,000 he was able to collect 100 times more by taking advantage of the ability to sell his policy. Even in the unlikely event that his policy had a cash value of $30,000, he still was able to receive 10 times more by using a life insurance settlement.

The Decline of Viaticals and the Rise of Pure Life Insurance settlements

Due to medical advancements, people with AIDS started living longer and therefore viatical settlements became less profitable. But this ushered in a whole new life settlement industry catering to anyone with an impaired life expectancy. The new forms of life settlements will accept people without termnal illness as long as they have “an age or other health consideration that shortens life expectancy.” In 2007, the life settlements transacted $12 billion in business. But due to the recession that amount fell to only about $3.8 billion in 2010. But there are $18 Trillion in active life insurance policies in the U.S. so there is a lot of opportunity and many people do not even know that it is possible to sell their policy.

Why Insurance Companies Don’t Like Life Settlements

Insurance companies count on the fact that more than two-thirds of policies lapse, i.e. the owner stops paying the premiums. So the insurance company was able to collect premiums for all those years and then doesn’t have to pay out anything. Often people have valid reasons for doing this. If the insured outlives the beneficiary he may feel that the insurance is no longer needed, so he stops paying. Another common scenario is where an elderly person feels they need the premium money more than the beneficiary needs the payout. In these and a variety of other cases life settlements could be a major benefit, if the insured just knew about the possibility. But because of Justice Oliver Wendell Holmes decision and recent developments the insurance industry has no choice but to cooperate and people have more options available.

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